Earnings Call Transcript - HESM Q4 2021

Operator, Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2021 Hess Midstream Conference Call. My name is Michelle, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

Jennifer Gordon, Vice President of Investor Relations

Thank you, Michelle. Good afternoon, everyone, and thank you for participating in our fourth quarter earnings conference call. Our earnings release was issued this morning and appears on our website www.hessmidstream.com. Today's conference call contains projections and other forward-looking statements, within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements. These risks include those set forth in the Risk Factors section of Hess Midstream's filings with the SEC. Also, on today's conference call, we may discuss certain non-GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the earnings release. With me today are John Gatling, President and Chief Operating Officer, and Jonathan Stein, Chief Financial Officer. In case there are audio issues, we will be posting transcripts of each speaker's prepared remarks on www.hessmidstream.com following their presentation. I'll now turn the call over to John Gatling.

John Gatling, President and Chief Operating Officer

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream’s fourth quarter 2021 conference call. Today I'll review our operating performance and highlights as we continue to execute our strategy. I'll provide details regarding our 2022 plans and discuss Hess Corporation's latest results and outlook for the Bakken. Jonathan will then review our financial results. 2021 was a year of strong performance and strategic execution for Hess Midstream. We're proud of our continued safe and reliable operating performance and project delivery, highlighted by the successful execution of the planned maintenance turnaround and tie-in of the gas processing and expansion at the Tioga gas plant. Following the turnaround, stable and reliable operating performance in the fourth quarter enabled us to finish strong with record gas gathering and processing volumes, driving full-year adjusted EBITDA above guidance to $909 million, an increase of 21% compared to 2020 and 4% above the midpoint of our original 2021 adjusted EBITDA guidance. Looking forward, the continued investment in low-risk system expansion gives us the needed capacity to capture volume growth through mid-decade. We remain focused on operational infrastructure and commercial execution to capture increasing gas volume growth, which by 2024 is expected to increase by more than 30% relative to Hess's 2021 nomination. We expect gas gathering and processing volumes to continue to comprise approximately 75% of our revenues. With a visible growth trajectory, we expect volumes to rise above MVCs in 2023 and continue to grow into 2024. Now focusing on Hess Midstream’s fourth quarter 2021 throughput performance, gas processing volumes averaged 330 million cubic feet per day, as our post-turnaround ramp-up drove results above expectations. Fourth quarter crude terminaling and water gathering volumes averaged 113,000 barrels of oil per day and 72,000 barrels of water per day, respectively. Now turning to Hess Upstream highlights. Earlier today, Hess reported fourth quarter results with Bakken net production averaging 159,000 barrels of oil equivalent per day, reflecting increased drilling activity, strong development performance, and continued focus on gas capture. For full year 2021, Bakken net production averaged 156,000 barrels of oil equivalent per day, in line with guidance. For 2022, Hess plans to operate a three-rig program and expects to drill approximately 90 gross operated wells and bring on approximately 85 new wells, an increase of 67% compared to 2021. This leaves more than 2000 future drilling locations beyond 2022, which generate attractive returns at $60 WTI per barrel and represents approximately 70 rig years of activity. In 2022, Hess forecasts Bakken net production to average between 165,000 and 170,000 barrels of oil equivalent per day, a 6% to 9% increase over 2021, and expects production to steadily ramp over the year, averaging between 175,000 and 180,000 barrels of oil equivalent per day in the fourth quarter. Additionally, Hess reiterated its commitment to sustainability as a top priority, announced its endorsement of the World Bank's zero routine flaring by 2030 initiative, and set company targets to eliminate zero routine flaring from its operations by the end of 2025. Hess Midstream is proud to partner with Hess to achieve its sustainability and climate goals. Turning to Hess Midstream guidance, our complete financial and operational guidance was released yesterday and is available on our website. For full year 2022, we expect gas processing volumes to average between 330 million and 345 million cubic feet per day, representing growth of approximately 11% compared to full year 2021, primarily driven by Hess's production growth and focused gas capture. Gas processing volumes are expected to remain generally at or below MVC levels in 2022, which are approximately 13% higher compared to 2021 physical volumes. For full year 2022, we anticipate crude terminaling volumes to average between 110,000 and 115,000 barrels of oil per day, water gathering volumes to average between 70,000 and 75,000 barrels of water per day. As physical volumes on most of our systems are at or below MVC levels, our 2022 forecast is approximately 95% revenue-protected, giving a high degree of confidence to our financial guidance, which projects adjusted EBITDA in the range of $970 million to $1 billion, an increase of approximately 8% at the midpoint compared to full year 2021. We expect first-quarter physical gas, oil, and water volumes to each be approximately flat compared to fourth quarter 2021, reflecting severe winter weather in North Dakota. Turning to Hess Midstream 2022 capital program, full year 2022 capital expenditures are expected to total $235 million, comprised of $225 million of expansion activity and $10 million of maintenance activity. Approximately $135 million of the 2022 capital expansion budget is focused on the completion of two new compressor stations and associated pipeline infrastructure. In aggregate, the new stations are expected to provide an additional 85 million cubic feet per day of installed capacity in 2022 and can be expanded up to 130 million cubic feet per day in the future. In addition, Hess Midstream expects to initiate construction on a third compressor station in 2022, which is expected to provide an additional 65 million cubic feet per day of installed capacity in 2023, further enhancing our gas capture capability and supporting development in the basin. By the end of 2023, we will have more than doubled our compression capacity from a few years ago, growing in line with Hess's drilling activity and our increased processing capacity. Reflecting increasing drilling activity by Hess, approximately $90 million is allocated to gathering systems and well connections. In summary, we're continuing to execute our strategy, making focused low-risk infrastructure investments to meet basin demands, delivering safe and reliable operating performance and strong financial results, which enables us to take advantage of future accretive growth opportunities, including potential incremental return of capital to our shareholders. I'll now turn the call over to Jonathan to review our financial results and guidance.

Jonathan Stein, Chief Financial Officer

Thanks, John. And good afternoon, everyone. Today I will summarize our financial highlights from 2021, discuss our recently completed nomination process with Hess, provide details on our 2022 guidance and long-term outlook, as well as our framework for continued return of capital to shareholders. We delivered strong results in 2021, growing full-year adjusted EBITDA to $909 million, an approximate 21% increase compared to the prior year. As we look forward to 2022 and beyond, we have clear visibility to expected revenue and adjusted EBITDA growth supported by increasing MVCs in 2022, followed by continued organic growth in 2023 and 2024, as John described. Returning capital to shareholders is a key priority of our financial strategy. In 2021, we optimized our capital structure and utilized our excess free cash flow beyond our growing distribution to provide increased return of capital to our shareholders through both a 10% increase in our quarterly distribution levels and a $750 million repurchase of units from our sponsors. Together, these actions delivered immediate, accretive, and meaningful return of capital to our Hess Midstream shareholders. Looking forward, we will continue our financial strategy that includes consistent and ongoing return of capital as a primary objective. Our return of capital framework includes the following key elements: first, distributions that are targeted to grow 5% annually on a per-share basis through at least 2024; second, continued incremental return of capital beyond these annual distribution increases through share repurchases and/or additional distribution increases funded by leverage capacity below our conservative three times adjusted EBITDA target and adjusted free cash flow after distribution. For 2022, we expect to have significant financial flexibility for potential incremental return on capital beyond our distributions that are targeted to grow 5% annually on a per-share basis. Turning to our results, we continue to deliver strong performance with fourth quarter 2021 results, beating our quarterly guidance. For the fourth quarter, net income was $165 million, compared to $131 million for the third quarter. Adjusted EBITDA for the fourth quarter was $247 million, compared to $205 million for the third quarter. The change in adjusted EBITDA relative to the third quarter was primarily attributable to the following: total revenues, excluding pass-thru revenues, were up by $20 million, driven by a strong volume ramp following the Tioga gas plant turnaround, resulting in segment revenue changes as follows; an increase in processing revenues of approximately $11 million; an increase in gathering revenues of approximately $10 million; and terminaling revenues decreased by approximately $1 million driven by slightly lower MVC levels. Total costs and expenses, excluding depreciation and amortization pass-through costs and net of our proportional share of LM4 earnings, decreased by $22 million, as follows: low operating expenses related specifically to the Tioga gas plant turnaround that was completed in the third quarter of approximately $14 million; lower other seasonal maintenance activity at the Tioga gas plant of approximately $5 million; and lower other costs and expenses net of our proportional share of LM4 earnings of approximately $3 million. Resulting in adjusted EBITDA for the fourth quarter of 2021 of $247 million, exceeding our guidance, primarily driven by lower than expected operating and maintenance expenses. Fourth quarter maintenance capital expenditures were approximately $2 million, and net interest, excluding amortization of deferred finance costs, was approximately $29 million. The result was that distributable cash flow was approximately $250 million for the fourth quarter, covering our distribution by 1.6 times. Expansion capital expenditures in the fourth quarter were approximately $52 million, resulting in adjusted free cash flow of approximately $163 million. At year-end, that was approximately $2.6 billion, representing leverage of approximately 2.9 times adjusted EBITDA on a trailing 12-month basis. Turning to our annual nomination process, our contracts continued to provide a unique and differentiated level of downside protection through a combination of our annual rate redetermination process that maintains a contractual return on capital and MVCs that provide revenue for Hess set at 80% of expected throughput three years in advance. With the contract extensions completed at the end of 2020, we now have commercial contracts with Hess with downside protection through 2033. At the end of 2021, we completed our nomination process with Hess and updated our tariff rates for 2022 and all forward years. As with prior cycles, the nomination process considered changes in actual and forecasted volumes and CapEx to maintain a contractual target return on capital deployed. 2022 tariff rates were generally stable relative to 2021, as higher expected volumes from Hess's accelerated development activity were mostly offset by higher expected capital investment. In our recent guidance release, we provide MVC to the year 2022 through 2024. As part of the nomination process, MVCs for 2022 and 2023 were reviewed and required an increase, while MVCs for 2024 were newly established based on 80% of the nominated volumes for each system in that year. Our MVCs provide line of sight to expected long-term growth in system throughputs and incremental revenue growth each year through a combination of increasing MVCs in 2022, followed by higher expected physical volumes in 2023 and 2024. For 2022, MVCs remained substantially unchanged from those previously set and at higher historical pre-pandemic basin activity levels. We expect 2022 physical volumes to be generally at or below MVCs. Most of our 2023 MVCs were revised higher, reflecting Hess’s accelerated pace of development in the Bakken and additional gas capture, and we anticipate physical volumes will grow above MVC levels in 2023. MVCs for 2024 were set at 80% of nominated throughputs and provide line of sight to potential long-term growth in systems throughputs. For example, looking at gas processing, Hess’s nomination for expected volumes for 2024 was 425 million cubic feet per day, resulting in an MVC of 340 million cubic feet per day, set at 80% of the nomination level, implying greater than 30% growth and an approximate 12% annualized growth rate in physical volume from 2021 actuals. We continue to expect gas gathering and processing to comprise approximately 75% of total affiliate revenues, excluding pass-through revenues. As a result, we have clear visibility to revenue and adjusted EBITDA growth through 2024, with MVC-supported growth in 2022, followed by year-on-year organic growth in 2023 and 2024. Turning to guidance for 2022. For the first quarter of 2022, we expect net income to be approximately $150 million to $160 million and adjusted EBITDA to be approximately $235 million to $245 million. First quarter maintenance capital expenditures, net of interest excluding amortization of deferred finance costs, are expected to be approximately $30 million, resulting in expected distributable cash flow of approximately $205 million to $215 million, delivering distribution coverage at the midpoint of the range of approximately 1.6 times. For the full year 2022, we expect net income of $630 million to $660 million and adjusted EBITDA of $970 million to $1 billion. At the midpoint of guidance, full year adjusted EBITDA is expected to increase by approximately 8% from 2021, primarily driven by higher gas gathering and processing MVC levels, as we expect our physical volumes to be at or above MVCs, with an adjusted EBITDA margin consistent with our historical margin of greater than 75%. By 2022, with total expected capital expenditures of $235 million, we expect the midpoint to generate adjusted free cash flow of $630 million. Highlighting our financial strength, we expect distribution coverage greater than 1.5 times, and excess adjusted free cash flow of approximately $90 million after fully funding our targeted growing distribution. As a result, we expect declining leverage of approximately 2.6 times adjusted EBITDA on a full-year basis in 2022, below our conservative 3 times adjusted EBITDA target. The combination of adjusted free cash flow beyond our distributions and leverage below our target provides significant financial flexibility for potential incremental return of capital to shareholders beyond our targeted 5% annual distribution per share growth. Looking beyond 2022, as described, our MVCs provide visibility to continue expected growth in adjusted EBITDA, supporting our ability to continue to fully fund our growing distributions from growing adjusted free cash flow through at least 2024 and to maintain ongoing financial flexibility for disciplined capital allocation. In summary, we are very pleased to deliver a strong 2021 and look forward to a visible trajectory of growth in our operational and financial metrics that underpin our unique and differentiated financial strategy, with a focus on consistent and ongoing return of capital to our shareholders. This concludes my remarks. We'll be happy to answer any questions. I will turn the call over to the operator.

Operator, Operator

Our first question comes from the line of Doug Irwin with Credit Suisse. Your line is open. Please go ahead.

Doug Irwin, Analyst

Maybe just to start with 2022 guidance. Given the volumes are expected to be below MVCs or at MVCs this year, just curious if you could elaborate a bit on some of the other factors that kind of drive the high versus the low end of the range—primarily cost variability and timing of these compression projects? Are there other factors involved?

Jonathan Stein, Chief Financial Officer

Yes. So in terms of our EBITDA guidance for the year, and the cadence of that, if you walk through the year, I gave guidance for Q1. As we said, in Q1 OpEx is going to be broadly flat relative to Q4. That's consistent with lower seasonal effects that we usually see during these quarters. In terms of revenue, which will be the driver for Q1, that's really driven there by oil and water—a combination of lower volumes based on weather, as John mentioned, and slightly low MVCs there on oil year-on-year. For the rest of the year, what we'll see is that OpEx will fall seasonally with Q2 and Q3; those are typically higher for us when we have more activity going on. Revenue will steadily increase through the year, so MVCs, while we give annual averages, are actually quarterly and they're increasing throughout the year. We'll see increasing revenue from that. To the extent that we have some systems like water that are above MVCs, that will be consistent with the Hess production ramp that Hess has discussed. In terms of EBITDA for the rest of the year, we see Q1 as a starting point and then expect higher EBITDA quarter-over-quarter for the rest of the year relative to Q1, which will get us to that $985 million midpoint of our EBITDA.

Doug Irwin, Analyst

Okay, that's helpful. Thank you. Then maybe just a follow-up on the CapEx guidance you gave. I know you pointed to $135 million on the compression projects. Does that include any of the spend through the expected third project that you talked about here? There's going to be some more spend on that next year. And then I guess, on the $90 million well connect CapEx? Should we look at that as a decent run rate beyond 2022? Or is that still a bit elevated this year with rigs coming back in the Bakken?

John Gatling, President and Chief Operating Officer

Sure. So I’ll start off with the $135 million question. The bulk of that spend is the completion of the two stations that will be coming on this year. There is some pre-construction engineering focus on that third station, but the bulk of that spend will be towards the end of this year and really into 2023. That’s where the bulk of the spend is from a compression perspective. Regarding the $90 million well connect CapEx— as the third rig comes on, and wells start to ramp up in 2022, we see that as a more representative spend profile associated with the well count, as Hess brings that third rig on and we actually start to see wells coming off that rig line. Additionally, Hess looks at potentially adding a fourth rig next year as well.

Operator, Operator

Thank you. Our next question comes from the line of Jeremy Tonet with JPMorgan. Your line is open. Please go ahead.

Dan Walk, Analyst

Hi, everyone. This is Dan Walk on for Jeremy. Just a couple of quick ones from us. The first, I guess, in light of yesterday's updates from Hess and from HESM just extending the financial framework through 2024. Given the significant flexibility, it sounds like you'll have even as early as by year-end, I think you mentioned 2.6x. Just curious if you could give an update on the opportunity set, particularly potentially in the Gulf of Mexico. There's a good deal of discussion on the Hess call earlier today about their plans this year. So just curious if we could get a quick update on that.

John Gatling, President and Chief Operating Officer

Yes, sure. And I'll hand it over to Jonathan for the financial flexibility piece of this. But from a Gulf of Mexico perspective, the transaction isn't an immediate priority for the midstream or Hess Corporation. We will continue to be focused on executing our strategy and supporting Hess's development and capturing third parties in the Bakken. So that's primarily our focus at this point. I'll hand it over to Jonathan for the financial flexibility part of the question.

Jonathan Stein, Chief Financial Officer

Sure. Thanks, John. Yes, I mean, I think with that background on Gulf of Mexico, we've already talked about our capital program that includes growth that we expect, which you can see in the MVC walkthrough. Our focus will be our financial strategy—the two elements I described that include a 5% annual distribution per share growth that will continue through 2024. Then, incremental return of capital beyond that distribution growth, either through share repurchases or additional distribution increases as we did last year. As I was saying, that was really a part of our ongoing financial strategy and our return on capital framework. For this year, as you highlighted, we have 2.6 times expected EBITDA on a full-year basis, which is declining relative to where we are now and certainly below our 3x target. You can do the math—relative to the midpoint of our EBITDA, that's $400 million in capacity that could be utilized to fund a potential incremental return of capital, really, with the Gulf of Mexico not being a priority. That is really the focus of our return of our financial strategy. In terms of actual sizing and timing, obviously, we'll evaluate that with the Board during the year, and that just gives us the full capacity. But certainly, as I've said, incremental return of capital is a key part of our financial strategy this year.

Dan Walk, Analyst

Okay, great. Thanks for that. And then just, I guess, a bit more granular. Following the Tioga plant expansion and the North Bakken expansion, could you just give us a little bit more detail? I assume all those volumes are flowing down to Northern Border, and BTU content is relatively high. I think there's an 1100 BTU cap. Where do you see that going in terms of ethane extraction, or just the dynamics from your perspective?

John Gatling, President and Chief Operating Officer

Sure. I mean, I think we're uniquely positioned with the Tioga gas plant. We've expanded the plant now by 150 million cubic feet per day; that got us up to 400 million there. We have 100 million down at our LM4 partnership with Targa as well. From the BTU content perspective and Northern Border, we've got a number of export options. We've got a connection with Alliance for both our wet gas. We also have our ethane connection, our long-term contract to deliver ethane up to Canada. We have the export with Northern Border. From our perspective, the plant is very efficient and has high recovery efficiency. We have no trouble meeting BTU specs if Northern Border decides to be more aggressive with their BTU specs; the plant is designed for significant BTU recovery. We don't see that being an issue for us. We also have the NGL takeaway capability tied into One Oak as well. Both plants are very well strategically placed with a number of export options. We really don't see any constraints from our perspective as far as getting our tailgate products to market.

Operator, Operator

Thank you. Our next question comes from the line of Michael Lipsitz with Goldman Sachs. Your line is open. Please go ahead.

Michael Lipsitz, Analyst

Congrats on the MVCs for 2024. Really healthy numbers obviously imply a pretty big pickup in production by Hess and, therefore, flowing through HESM. Just curious as you think about capital spends for '23 and '24, and I know you won't give guidance on that for another year. Should we assume that there is a pretty material pickup in capital spend in '23 and '24 to help facilitate the increase in volume levels that Hess expects in 2024? Would you think by the end of this year or early next year, your system will be built out enough to handle the '24 volumes?

John Gatling, President and Chief Operating Officer

Sure, Michael. Thanks for the question. From our perspective, our compression is really phased with the development. When we made the decision back in '19 to expand the Tioga gas plant, that's brought our total processing capacity up to 500 million cubic feet per day, between Tioga and the Little Missouri gas plant partnership with Targa. From our perspective, the processing is well set. We've been phasing in compression, as Hess has made its decision to accelerate development activity. We're going to bring on two stations this year, and we're going to potentially bring on a third station next year. Our infrastructure is planned out and supports the 2024 volume projections based on the MVCs. I would say it's materially there. We're going to continue to see some investment in compression over the next several years to meet our processing capacity. Obviously, the well connections will be something that will be a bit more fluid as Hess decides its pace of development. But from an infrastructure perspective, we are not expecting to see any significant increases in our capital spend. I don't know, Jonathan, if there's anything else you wanted to add to that.

Jonathan Stein, Chief Financial Officer

No, I think you hit it well. We're in a unique position where the capital needs that John described really are now just focused on well connects and compression, and we're really at or below the levels that we have now, which will achieve the growth that's in our plan. That leaves us with significant financial flexibility going forward, as we've talked about. We're not considering, as we've been clear about, any large-scale M&A. Obviously, we'll look at investment opportunities in a disciplined way as we've done in the past. But it's very clear that our priority for us is that our financial strategy is focusing on that financial flexibility for continued return of capital to shareholders.

Michael Lipsitz, Analyst

Got it. Thank you for that. Just one last follow-up. Can you remind me, and I listened to part of the Hess call, what's the timing Hess has been thinking about for the fourth rig?

John Gatling, President and Chief Operating Officer

Sure. The timing that Greg mentioned in the call was really looking at 2023. The plan would be that, if prices hold, there's over 2100 well locations available for future development at $60 WTI per barrel. From an overall inventory perspective, Hess has a very strong portfolio. The plan would be to continue with the third rig this year and then potentially bring on the fourth rig in 2023.

Operator, Operator

Thank you. This concludes today's question-and-answer session as well as today's conference. Thank you very much for your participation, and you may now disconnect. Everyone have a great day.